What Happens When a Country Declares Bankruptcy?

by Shane Hall; Updated September 26, 2017

The fallout from the economic crisis of 2008 was not limited to troubled homeowners, mortgage lenders, and major financial institutions. The crisis spread further, leaving entire nations facing financial ruin. A national insolvency is not a simple matter of a country going to court and filing for bankruptcy. Rather, a nation going bankrupt triggers serious economic consequences at home and abroad, often requiring rescue from foreign investors or global institutions such as the International Monetary Fund.

Definition

The German newspaper "Spiegel" reported on the issue of national bankruptcies in 2008, after the island nation of Iceland neared insolvency. When a country can no longer pay the interest on its debt or convince anyone to lend it money, it has reached bankruptcy. Possible causes of a country’s bankruptcy can include war or financial mismanagement by the government, the newspaper reported.

History

An entire nation becoming financially insolvent is not a new phenomenon. "Spiegel" reported in a 2008 article that Germany went bankrupt twice in the 20th century: once in 1923 after World War I and again after the end of World War II in 1945. Since then, the newspaper reported, Russia has gone bankrupt in 1998, followed by Argentina in 2001. In 2008 Iceland became the first country to fall victim to the financial crunch that resulted after the collapse of the U.S. housing market. "Spiegel" reported that other countries, including the Ukraine and Pakistan, face financial ruin as well.

Effects

When a nation becomes bankrupt and defaults on its loans, central banks may try to attract additional foreign investors by raising the interest rates on the country’s bonds. "Spiegel" reported that Iceland’s central bank raised its prime rate to 18 percent in 2008 while Venezuela offered 20 percent interest in hopes of selling its bonds. Such large hikes in interest rates negatively impact the credit ratings of the countries themselves, which "Spiegel" said often results in lenders writing off the loans the countries can no longer repay.

Massive Inflation

When a country reaches bankruptcy, massive inflation is the likely outcome for the country’s consumers and businesses. Stock prices often plummet, along with the value of the nation’s currency. As the value of money falls, bank runs may result as panicked citizens rush to withdraw cash from their accounts. This occurred in Argentina in 2001 after the government there froze bank accounts, limiting the amount of money people could withdraw. "Spiegel" said many desperate Argentines even slept in front of ATMs, hoping to withdraw what cash they could.

Warning

In some cases, social and political unrest can result if a nation goes bankrupt. In Argentina, angry residents rioted and looted supermarkets in the wake of the country’s 2001 insolvency. In Iceland, the head of the country’s central bank was forced to resign after that country’s crisis, which cost thousands of Icelanders their jobs and life savings, according to a 2009 report by "The Times of London."

Prevention/Solution

To avert bankruptcy or to cope with its effects, insolvent governments often look abroad for a bailout. Nations in the most dire straits seek emergency loans from the International Monetary Fund (IMF). Recipients of IMF assistance have included Hungary and the Ukraine. IMF assistance, however, comes with strings attached. In exchange for IMF help, "Spiegel" reported, the Ukraine was forced to freeze social spending, privatize some government services, and increase natural gas prices.

Potential

In 2009 Harvard historian Niall Ferguson predicted that a growing number of European nations were in danger of bankruptcy. In a report by "The Guardian" newspaper of the United Kingdom, Ferguson said Ireland, Italy, and Belgium were in the greatest danger of bankruptcy, with the U.K. also at risk.

Resources

About the Author

Shane Hall is a writer and research analyst with more than 20 years of experience. His work has appeared in "Brookings Papers on Education Policy," "Population and Development" and various Texas newspapers. Hall has a Doctor of Philosophy in political economy and is a former college instructor of economics and political science.